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Estimating the effects of forward guidance in rational expectations models

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  • Harrison, Ricahrd

Abstract

Simulations of forward guidance in rational expectations models should be assessed using the “modest interventions” framework introduced by Eric Leeper and Tao Zha. That is, the estimated effects of a policy intervention should be considered reliable only if that intervention is unlikely to trigger a revision in private sector beliefs about the way that policy will be conducted. I show how to constrain simulations of forward guidance to ensure that they are regarded as modest policy interventions and illustrate the technique using a medium-scale DSGE model estimated on US data. I find that, in many cases, experiments that generate the large responses of macroeconomic variables that many economists deem implausible – the so-called “forward guidance puzzle” – would not be viewed as modest policy interventions by the agents in the model. Those experiments should therefore be treated with caution, since they may prompt agents to believe that there has been a change in the monetary policy regime that is not accounted for within the model. More reliable results can be obtained by constraining the experiment to be a modest policy intervention. The quantitative effects on macroeconomic variables are more plausible in these cases.

Suggested Citation

  • Harrison, Ricahrd, 2014. "Estimating the effects of forward guidance in rational expectations models," LSE Research Online Documents on Economics 86327, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:86327
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    File URL: http://eprints.lse.ac.uk/86327/
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    References listed on IDEAS

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    1. Alan S. Blinder & Michael Ehrmann & Marcel Fratzscher & Jakob De Haan & David-Jan Jansen, 2008. "Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence," Journal of Economic Literature, American Economic Association, vol. 46(4), pages 910-945, December.
    2. Burgess, Stephen & Fernandez-Corugedo, Emilio & Groth, Charlotta & Harrison, Richard & Monti, Francesca & Theodoridis, Konstantinos & Waldron, Matt, 2013. "The Bank of England's forecasting platform: COMPASS, MAPS, EASE and the suite of models," Bank of England working papers 471, Bank of England.
    3. Malin Adolfson & Stefan Laséen & Jesper Lindé & Mattias Villani, 2005. "Are Constant Interest Rate Forecasts Modest Policy Interventions? Evidence from a Dynamic Open-Economy Model," International Finance, Wiley Blackwell, vol. 8(3), pages 509-544, December.
    4. Hess Chung & Michael T. Kiley & Jean-Philippe Laforte, 2010. "Documentation of the Estimated, Dynamic, Optimization-based (EDO) model of the U.S. economy: 2010 version," Finance and Economics Discussion Series 2010-29, Board of Governors of the Federal Reserve System (U.S.).
    5. Adolfson, Malin & Laséen, Stefan & Lindé, Jesper & Villani, Mattias, 2005. "Are Constant Interest Rate Forecasts Modest Interventions? Evidence from an Estimated Open Economy DSGE Model of the Euro Area," Working Paper Series 180, Sveriges Riksbank (Central Bank of Sweden).
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    Cited by:

    1. Nadav Ben Zeev & Christopher M. Gunn & Hashmat Khan, 2015. "Monetary News Shocks," Carleton Economic Papers 15-02, Carleton University, Department of Economics, revised 17 Feb 2017.

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    JEL classification:

    • J1 - Labor and Demographic Economics - - Demographic Economics

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